Buying a home is one of the biggest decisions you’ll ever make, both for your finances and your personal life. For most people, it represents a commitment to live in one place — at least for a few years — and to put a huge amount of your savings into the home. Once you sign the paperwork and the funds are transferred, there’s no going back.
People often don’t realize that the transaction costs when buying a home are so significant that if you decide to turn around and sell the home one year later you will likely lose quite a bit of money. That’s why it is so important to know if you’re ready to buy a home before you even start looking at homes for sale. How do you decide if you’re ready? Use the 5 questions below:
1. Are you sure you’ll stay in the home for 5 years?
Houses usually appreciate in value anywhere from 1-5 percent per year, and that is what can help offset the transaction costs mentioned above. But you typically need to live in the home for at least 5 years to enjoy enough appreciation to make your initial investment profitable. In other words, the longer you stay in your home the better your odds of making money whenever you sell it.
If you use an online rent vs. buy calculator like this one, you will usually see that buying is only a better option after about 5 years. See below for an example:
Owning a home is an investment in your future. But it only pays off in the long run — after a number of years. That’s why you should be prepared to live in the home for quite some time. Otherwise, you’re better off renting or exploring alternative paths towards homeownership, like Divvy.
2. Do you have enough income?
While you’re probably used to coming up with a monthly rent payment for your current accommodations, having a monthly mortgage payment for 30 years can be a little more intimidating. Remember, if you don’t pay your mortgage you can lose the home and any equity you have in it. That would be even worse than being evicted from an apartment or rental.
To avoid getting in over your head, look at home prices in your area and run the numbers through a mortgage calculator like this one to see what the monthly payment would be, including principal and interest (P&I) plus taxes and insurance. See an example below:
As a general rule of thumb, experts recommend paying no more than 30% of your pre-tax income on housing. So if your monthly income is $5,000 then your mortgage payment should be $1,500 or less. That’s assuming you don’t have any other debt, like credit cards or auto loans. If so, you’ll need to work those into your calculations as well. If the home prices in your area don’t allow you to get a mortgage that meets your budget, then it might be best to continue renting or check out other options, like Divvy.
3. Is your credit score high enough?
These days, lenders have pretty strict criteria when it comes to mortgage applications. In most cases, you need a credit score of at least 620 to get approved for a conventional mortgage — and even that may not be enough sometimes.
For other loan types, such as FHA or VA loans, you may be able to qualify with a credit score of 580 or even 500. This will depend upon what kind of down payment you are going to use. See the chart below for a comparison:
|Loan Type||Minimum Credit Score||Designed For|
|Conventional||620 to 640||Buyers seeking a traditional mortgage|
|FHA||580 with 3.5% down
500 with 10% down
|Low- to moderate-income homebuyers|
Source: U.S. News & World Report
If your credit score is not high enough to be approved for a mortgage, then it’s probably best to wait and spend some time improving your score. There are a number of ways to do this, including paying down your outstanding balances and fixing errors on your credit report. In the meantime, you can continue renting or consider using Divvy, which helps you work on your credit while you’re already living in your dream home.
4. Do you have enough cash for a down payment and closing costs?
One of the hardest things to do when preparing to buy a house is to save up for a down payment. Many people prefer to save up 20% of the home’s value for a down payment, because this brings down the monthly payment and helps you avoid paying private mortgage insurance (PMI).
However, in some cases it may not be possible to save up 20% and that might be okay as long as the monthly mortgage payment is still within your budget. As mentioned above, there are special government loans, including FHA mortgages, that only require a down payment of 3.5%. These can be a great option for some people.
If you find that you don’t have enough cash for a down payment, you can make a plan to save up for one. Set a goal of 1-2 years and see how much you’re able to save in that time. You can also try Divvy if you want to get into a home today while continuing to save up.
5. Can you afford home repairs and maintenance?
One last thing many people forget is how costly home maintenance and repairs can be on a monthly or yearly basis. If your water heater breaks or your roof leaks or your pipes burst, you’ll need to spend thousands of dollars on the repairs. There are other expenses that might be smaller, such as a new coat of paint (inside our outside), a new fence, a new deck, or new gutters. While these seem like no big deal, they can add up quickly.
Experts recommend that you plan to spend at least 1% of the home’s value on maintenance per year. So if your home is worth $300,000 you should plan to spend $3,000 each year on necessary repairs.
If you can comfortably say “yes” to each of the 5 questions above, then chances are good you’re ready to buy a home – congratulations! Your next step could be talking with a real estate agent, submitting a mortgage application, or checking out some open houses in your area.
If you were not able to answer all of the questions affirmatively, then you might need to wait a little longer to buy a home. Remember, it’s not the end of the world to wait until you’re ready. The worst case would be buying a home and having to give it up because you weren’t able to make the monthly payments.
We also think you should consider Divvy, which is a bridge to homeownership for people who are not quite ready to buy a home. With our program, you choose the home, and Divvy buys it for you (yes, really!). Then, you live in the home while you rent for up to 3 years, with a portion of every payment going towards your future down payment. Buy the home at any time and use your savings for your down payment on a mortgage or move & cash out your savings. Divvy keeps things flexible for your changing life.
If that sounds interesting, reach out to us to learn more at DivvyHomes.com.